Journal Article
No. 2010-12 | April 14, 2010
Rudiger Ahrend
Monetary Ease: A Factor behind Financial Crises? Some Evidence from OECD Countries
(Published in Policy Paper)


This paper addresses the question of whether and how easy monetary policy may lead to excesses in financial and real asset markets and ultimately result in financial dislocation. It presents evidence suggesting that periods when short-term interest rates were persistently and significantly below what Taylor rules would prescribe are correlated with increases in asset prices, especially as regards housing, though no systematic effects are identified on equity markets. Significant asset price increases, however, can also occur when interest rates are in line with Taylor rules, possibly associated with periods of financial deregulation and/or innovation. Finding also some support for a link of countries’ pre-crisis monetary stance with the extent to which their financial sectors were hit during the recent crisis, the paper argues that accommodating monetary policy over the period 2002–2005, probably in combination with rapid financial market innovation, would, in retrospect, seem to have been among the factors behind the run-up in asset prices and financial imbalances—the (partial) unwinding of which helped trigger the recent financial market crisis.

JEL Classification:

E44, E5, F3, G15


Cite As

Rudiger Ahrend (2010). Monetary Ease: A Factor behind Financial Crises? Some Evidence from OECD Countries. Economics: The Open-Access, Open-Assessment E-Journal, 4 (2010-12): 1–30.

Comments and Questions

Anonymous - Monetary Ease Paper
April 19, 2010 - 23:46
This paper relies heavily on Taylor rules for its investigation of whether monetary policy is a factor behind financial crises. One wonders whether this is a helpful exercise in view of the serious problematic nature of the Taylor rules, some, but not all, of which are acknowledged in the paper.

Laurence Copeland - Globalisation
May 18, 2010 - 11:52 | Author's Homepage
Interesting and thought-provoking. However, the paper all but ignores the elephant - or, rather, the dragon - in the room, noting it only in footnote 3. It is hard to see how much faith one can have in Taylor Rules based on data for the decades before the emergence of China and India. The increase in effective labour supply in a globally integrated world economy makes the concepts of NAIRU etc obsolete, or at least in urgent need of redefinition. My own guess about the chain of causation underlying this paper is (in very broad terms, and ignoring a lot of detail) as follows. Monetary expansion in developed economies, which would previously have caused consumer price inflation as output bumped up against its ceiling, instead boosted demand in China and India, which they were able to satisfy at more or less constant price, thanks to their ability to suck workers in from their vast underemployed agricultural labour forces. In order to prevent their exchange rate from appreciating in response, the Chinese “recycled” the dollars they accumulated to the US market, largely in the form of T-bond purchases, keeping US interest rates low and liquidity high. With inflation expectations low, the financial sector responded by buying assets or lending to those who wanted to do so, reducing returns on capital to match the low real yields on T-bonds etc. The housing market was the obvious destiny for such enormous capital flows: it had a history of credit constraint and consequent suppressed demand, its overvaluation was easier to conceal (given its heterogeneity) than would have been the case for, say, quoted stocks, and most importantly, mortgages had support across the political spectrum, making expansion easy – and the prospect of an eventual bailout almost a certainty. The story was very similar in UK, and possibly other countries too. In the Eurozone, the picture was more complicated, but something similar appears to have happened in Ireland at least.